Archive for the Category Efficient markets hypothesis

Update: This Dean Baker post suggests the WSJ article is highly misleading, in which case I was too hard on Obama.

The WSJ has an article discussing some comments made by President Obama, back in February 2009. While speaking to Senator Reid, he indicated that the next day’s jobs report would be bad. It was bad, unemployed rose to 7.6%. Reid later mentioned these comments on the Senate floor.

That’s clearly something that Obama should not have done. So why do I think Trump’s actions were worse?

If you go back to that period, everyone knew the jobs number was going to be horrific. We’d recently been losing a massive number of jobs every month. No, that doesn’t excuse the action; the leak did remove a tiny tail risk that the numbers would be OK. But basically it would be pretty hard to profitably trade on the Obama leak. If you could go back in a time machine, how would you trade on that inside information? Sell stocks and buy Treasuries? Sorry, but stocks soared dramatically higher after the jobs report, and Treasuries fell as bond yields rose strongly. So Obama wasn’t really giving away any useful information:

Analysts said they were cheered that financial markets seemed to shrug off a government report showing that unemployment climbed to 7.6 percent in January as the recession deepened, a sign the job market was still far from hitting bottom.

“It’s a good sign that we’re trading up in the face of bad news,” said Ed Hyland, global investment specialist at JPMorgan Private Bank. “That’s one of the signs that you look for in the bottoming of a bear market.”

Although the statistics were grim, the so-called whisper numbers representing the most pessimistic estimates on Wall Street guessed that unemployment could have spiked to 8 percent last month, given the mass layoffs announced by employers.

Basically, Obama was leaking common knowledge that the jobs market sucked in January 2009.

Again, that’s not to defend his action; he should have kept his mouth shut. But Trump’s action was worse. Anyone who knows how Trump thinks would have interpreted his comment as an indication that a pretty decent jobs number was likely to occur. Why would Trump do that tweet if the number was going to come in worse than expected? Unlike with the Obama leak, traders who were lucky enough to see his tweet at 7:21am could have profited from the leak.

Of course the WSJ knows all of this, but chose not to publish the information. To use David Henderson’s terminology, that’s “unforgivable“.

PS. With Trump there are two types of people, those who see the elephant in the room, and those that cannot see it. Almost every day there is a new Trump outrage. When it occurs, some people dig up some sort of similar event with one of America’s previous 44 presidents. They fail to see the pattern here, the uniquely outrageous nature of Trump. It’s like a dot picture of an elephant:

Some people see the elephant, while others just see a bunch of individual dots–none of which look like an elephant.

None of Trump’s individual outrages make him look particularly awful. It’s the daily drumbeat that paints the true picture. You either see it or you don’t. For those who cannot, I can’t help you.

Interestingly, America’s white nationalists do see the picture accurately. They get it. They see how all the points fit together. That’s why they love Trump.

I’ll say this for Trump, he’s far and away the most entertaining president in history. Hardly a day goes by without a new outrage:

Mr Trump said in a tweet at 7.21am US eastern time that he was “looking forward to seeing the employment numbers” which were due for release at 8.30am. His decision to refer to the numbers before the release prompted a backlash, given that he had advance sight of the one of the world’s most market-sensitive pieces of economic data and was discussing it publicly.

First of all, the jobs report is not one of the most market sensitive pieces of information, it is the most market sensitive. On average, the jobs report moves the bond market more than any other piece of government data. Second, why is any president given this sort of inside information? It increases the chance that the data will leak out before the official release. Third, why is it given to Trump of all people, who has already shown an inability to keep highly confidential information secret?

Asked if the tweet was appropriate, Sarah Sanders, the White House spokeswoman, said that it was. “He didn’t put the numbers out,” she said. The president had been briefed on the number on Thursday night, she said.

Can I use that excuse if the Feds ever prosecute me for conspiracy to trade on inside information?

Every time I see Sarah Sanders talk I wonder whether she’s actually as clueless as she looks or if she is just pretending to be a moron. I guess we’ll have to wait for her memoir to find out.

I’d be very interested if a commenter could explain to me why the President needs to know this information before 8:30am.

When I stated blogging in early 2009, people were incredulous when I blamed the recession on tight money. Most people thought it was “obvious” that the recession was caused by the house price bubble. (There was no housing construction bubble–Kevin Erdmann has lots of research showing that housing construction during the 2000s was at normal levels.)

OK, if was obvious that home prices were wildly excessive in 2006, why is that not also true today? Nominal house prices are now far above 2006 levels, and even in real terms they are rapidly approaching the 2006 peak, as this graph shows (deflating by the PCE index):

So let’s see what these pundits say today. Are they calling for investors to engage in “the big short”, as John Paulson did in 2008? Are they predicting another Great Recession? Are they predicting another crash in housing prices? Are they predicting another banking crisis? If not, why not?

Is it possible that the housing boom was not a bubble? Is it possible that fundamentals (such as building restrictions and lower real interest rates) support much higher real housing prices during the 21st century than during the 20th century? Is it possible that the real problem was nominal, a fall in NGDP engineered by a monetary policy that (during 2008) held the Fed’s target interest rate far above the equilibrium interest rates? Is that why unemployment stayed low as housing construction fell in half between January 2006 and April 2008, and then soared when tight money pushed NGDP down in late 2008?

Lots of pundits were saying housing prices were excessive as far back as 2003; when even in real terms they were far lower than today. Do these same pundits again predict a collapse? If not, why not?

It’s rare that life gives us a second chance to test a theory. Let’s not waste it; let’s follow this experiment quite closely over the next few years. I plan to, and I’ll keep reminding people of the outcome.

Tim Harford has a very good piece on bubbles in the FT. This caught my eye:

Yet even with hindsight things are not always clear. For example, I first became aware of the incipient dotcom bubble in the late 1990s, when a senior colleague told me that the upstart online bookseller Amazon.com was valued at more than every bookseller on the planet. A clearer instance of mania could scarcely be imagined.

But Amazon is worth much more today than at the height of the bubble, and comparing it with any number of booksellers now seems quaint. The dotcom bubble was mad and my colleague correctly diagnosed the lunacy, but he should still have bought and held Amazon stock.

I wish I had bought Amazon in the 1990s, just as I wish I had bought Bitcoin at $12, when I was writing posts claiming that it was not a bubble. But I didn’t, and given what I knew at the time there was really no reason for me to do so. But what about the claim that “the dotcom bubble was mad”? I do recall people saying that in 2002, after the bubble had burst and the NASDAQ fell to 1200. But is that true?

The argument made in 2002 is that tech valuations made no sense unless you believed that tech companies would push aside old stalwarts like GE, GM and Walmart, and that companies like Apple and Amazon would become the most dominant corporations on Earth. Well, hasn’t that happened? Another argument was that you’d have had to believe that all the dotcom companies would be successful. Actually, if you didn’t know which ones would be successful, it would have made sense to buy an index fund in the NASDAQ.

The NASDAQ peaked at just over 5000 in early 2000, but that was for just a very brief period. The average “mad” dotcom investor would have purchased stock at some time during 1999 or 2000, probably at a NASDAQ level closer to 3500 or 4000. NASDAQ is now above 7200, and if you add in dividends it would not be unusual for an investor to have doubled their money over 18 years. That’s not particularly good for a risky investment, but it’s not horrible. It’s a higher rate of return than T-bills, but lower than T-bonds. But keep in mind that T-bond investors lucked out, as actual NGDP growth was far less than expected when T-bonds were yielding 6%, and if people had known what was going to happen to the US economy, yields would have been far lower in 2000. Alternatively, if NGDP had grown as expected, the NASDAQ would be far higher today.

Just to be clear, even today it seems like the tech market was a bit frothy at the peak in March 2000, I’m not denying that. But my point is that all of these judgments are provisional. If people really believe that markets are irrational, they ought to be writing posts in the FT talking about the negative bubble of 2002. What were those morons thinking when they sold tech stocks when NASDAQ was at 1200? Were they insane? Were they idiots? Instead, pessimism is intellectually respectable so the pessimists get off scot-free, while optimists are ridiculed for being wrong. Why?

Here’s how the FT article starts out

“Prices have reached what looks like a permanently high plateau.” That was Professor Irving Fisher in 1929, prominently reported barely a week before the most brutal stock market crash of the 20th century. He was a rich man, and the greatest economist of the age. The great crash destroyed both his finances and his reputation.

The fact that Fisher’s wrong prediction had any impact on his reputation is a sad commentary on our society. His forecast should have attracted no more attention than his forecast as to who would win the World Series. Would Fisher’s reputation have been damaged if he got a baseball game wrong?

And if we really should trash people for their bad calls on the market, why isn’t Robert Shiller’s reputation damaged for his claim that stocks were overpriced in 2011, when in fact it was near the beginning of one of the great bull markets in US history? Why trash the optimists but not the pessimists?

And why aren’t the Chinese bears being called to account for all their predictions of a crash in the Chinese economy, or of 3% average real GDP growth during the decade of the 2010s?

Just to be clear, I’m not saying anyone’s reputations should be trashed. My complaint is that other people are trashing great economists like Irving Fisher with no justification at all.

Speaking of China, remember all those predictions that it would get stuck in the middle-income trap? Read the following from another FT story, and ask yourself how often you read those sorts of things about Turkey, Brazil or other countries that are actually stuck in the middle-income trap:

Here, too, China is catching up. Chinese internet leaders Tencent and Alibaba have a combined valuation of $1tn. Add in another $200bn or so for Baidu, JD.com and Netease plus other listed or unlisted companies, such as Toutiao, Meituan and Didi, and the scale of the Chinese market becomes apparent. Trends emerging in China are beginning to shape the future of the global tech landscape. To its dominant role in the supply chain we can now add a “demand chain” aspect to the country. . . .

Massive investments in mobile broadband and a highly competitive handset market means that nearly all of China’s approximately 750m internet users use smartphones. Payments via QR codes, led by Tencent’s WeChat and Alibaba’s Alipay, are making cash obsolete. Dockless bikes line the streets of Chinese cities. The country’s physical infrastructure — roads, high-speed trains and airports — are facilitating as big a boost to consumption as President Eisenhower’s roll out of the Interstate Highway System in the US in the 1950s.

I have lived in Beijing for more than 20 years, yet only in the past year have I felt on returning to London or Silicon Valley that I’m going backwards in time. For urban residents, China is increasingly a study in frictionless living. Hopping on a bike, ordering a meal from a huge range of restaurants, paying for utilities, transferring money to friends — all can be done at the touch of a button. Internet services in the west offer increasing convenience no doubt — but nothing beats the experience in China.

What part of “developed country” is China not going to be able to do by 2035? Be specific.

I am enough of a supply-sider to think the answer is “yes”, and enough of a realist to think the growth effects will be quite modest, maybe a couple tenths of percent per year over the next decade (mostly front-loaded). Michael Darda recently provided a much better explanation than I can:

Our friend Scott Sumner often says “real economists don’t forecast, they infer market forecasts”. On this score, those who believe that the Tax Cut and Jobs Act will drastically ramp up growth typically point to the stock market gains YTD and then argue that a gush of capital will come flowing in as corporate tax rates fall. There are a few major problems here, in our view. First, we have had a global equity market boom in 2017, with markets in Europe and Japan up by similar magnitudes and emerging market equities up 30% YTD, outperforming the S&P 500 by 1000 bps. Surely, the TCJA cannot explain why emerging market equities are outperforming domestic equities as the latter are the ones supposedly being lifted by fiscal policy expectations. Moreover, if markets expected a “rush of capital” to come pouring into the U.S., why has the dollar basically done nothing as the tax bill’s chances of passage have become almost certain? Some argue that this is because the Fed is going to “accommodate” the tax cut, meaning that despite projections for higher deficits, they will not tighten more as a result. Well, this is very hard to square with the bond market, which shows no significant pop in real rates (which is consistent with the dollar story); hence, there is no big expected jolt to supply-side growth expectations and also very little movement in inflation breakeven spreads, which means no big expected pop to the demand side. If the tax cut were expected to be expansionary, and the Fed were expected to accommodate said tax cut, why is the yield curve continuing to flatten instead of steepening? . . .

With all this in mind, why, you may ask, are we advancing a debt-funded tax cut at a time of near full employment, which will likely add at least an additional trillion to a net $10 trillion in cumulative deficits over the next decade (HT, Caroline Baum<https://twitter.com/cabaum1/status/942475783175655427>)? We do not know and no one in Congress has given a good explanation as to why.

I would add that the market forecast of the impact of new policies is the optimal forecast (pity we don’t have a RGDP futures market) and anything we observe subsequently will be less informative than the market prediction. Recall my posts on how there is no “wait and see” with monetary policy initiatives. You discover within 5 minutes almost everything you will ever know about the effectiveness of moves like QE.

I see the market response to the tax cut as being consistent with my view of “some effect, but modest”. A lot like QE!

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Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.